SCM

Optimal reorder interval

Continuous-review inventory model,

Safety stock = z x σL = NORM. INV (α,0,1) x √L x σ

Lead time of shipping from factory to Europe = 5 weeks

Cycle service level = 98%

Product cost = $400

Holding cost per year = 30% of product cost

NORM.INV(0.98,0,1) =2.053748911

Average Inventory

= (Q/2 )+ Safety Stock

Order-Up-To Level,

S = s + Q

Factors driving safety inventory

-Replenishment lead time: If lead time is reduced by a factor of k, the required safety inventory will be reduced by a factor of √k

-Demand uncertainty: If σ is reduced by a factor of k, safety inventory will be reduced by a factor of k

-Service Level

Periodic Review Policy

r : Reorder interval (review period)

S: Order-up-to level (base-stock level)

Average Inventory

= (r D/2) + Safety Stock

Comparing Continuous Review & Periodic Review Policies

Factors driving safety inventory in periodic review policy

– Demand uncertainty

– Replenishment lead time

– Reorder interval

– Service level

Periodic review policy is easier and cheaper to implement

Periodic review policy requires more safety inventory than continuous review policy for the same lead time and service level

p = sale price

c = purchase price

s = outlet price or salvage value

Cu = underage cost per unit

Co = overage cost per unit

a = probability that demand will be at or below order quantity

Optimal Decision

expected marginal cost = aCo = a(c s)

i.Proposals of European factory 

Pros

Cons

Reduce the lead time and transportation cost 

High initial setup cost 

Increase the responsive ability 

Less economies of scale 

Improve service level 

Increase the uncertainty and cost of raw materials

Avoid loss sales 

ii.Proposals of better forecasting 

Pros 

Cons 

Minimize the inventory level 

High system setup cost 

Better production planning 

Based on assumptions 

Better material management 

Based on the past data 

Effective handling of the uncertainty 

Require high term behavioral insight from market research 

Better utilization of capital 

iii.Proposals of more inventory 

Pros

Cons

Improve service level 

Higher inventory holding cost 

Avoid loss sales 

Risk of inventory damage or loss 

Higher economies of scale 

Risk of inventory obsolescence 

Provide buffer for supply or demand uncertainty 

Less cash flow flexibility 

Reduce production lead time 

Lower the unit transportation cost / per unit production setup cost 

Fully utilize production capacity 

Factors Affecting Value of Aggregation

1. Demand correlation

-Aggregation reduces demand variant (and thus safety inventory) if demands are not perfectly positively correlated

-Square root law: If demand in different regions is about the same size and independent, aggregation reduces safety inventory by the square root of the number of areas aggregated

-Note that inventory aggregation does not have to physically centralize inventory. Information centralization (virtual aggregation) would achieve the same goal of reducing safety inventory.

2. Coefficient of variation of demand

-Coefficient of variation = standard deviation / mean

-The higher the coefficient of variation of demand of a product, the larger the impact on safety stock reduction as a result of aggregation

3. Value of product

-High-value products will provide a greater benefit from aggregation than low-value items

Levers to Reduce Safety Inventory

-Reduce information uncertainty in demand

-Reduce replenishment lead time

-Reduce supply uncertainty or replenishment lead time uncertainty

-Increase review frequency in a periodic review policy or use continuous review policy

-Physical centralization and information centralization

Specialization

->Centralize slow-moving products which typically have a high coefficient of variation to achieve the largest benefit of aggregation

->Leave fast-moving, low-value products closer to customers to provide faster service and save delivery cost

-Product substitution

->Substitution aggregates demand across the components and therefore reduces the safety inventory

->The higher the demand uncertainty, the more benefit from the substitution

->If the cost difference is small, one should carry more higher-value components to substitute the shortage of lower-value product

->If demands are strongly positively correlated, there is little benefit of substitution (just as aggregation)

->Joint management of inventories across substitutable products

-Component commonality and postponement

->Component commonality allows the aggregation of raw material inventory

->As the common component is shared by increased number of finished products, the cost of the component or the finished products that use the component increases as it requires more flexibility from the component or the product design

->By postponing product differentiation or customization until closer to the time the product is sold, the producer would have common components in the supply chain for most of the push phase.